Does a Roth conversion make sense at 73?

Dan Moisand,
a Principal at Moisand Fitzgerald
Tamayo, LLC in Melbourne and Orlando, Fla., is one of the financial
planning profession’s most respected practitioners advising retirees and near
retirees. Dan’s thoughts can be found in bylined articles in most major
publications for financial planners and a slew of financial planning related
publications have featured him as one of America’s top advisors and was recently
named one of
"15
transformational advisers" by InvestmentNews. A past national
President of the Financial Planning Association (FPA), his service to the
profession includes three years on the CFP Board of Practice Standards crafting
the standards to which all US CFP’s must adhere and serving as Chairman of the
CFP Board’s Discipline and Ethics commission, the body that judges complaints
against CFP licensees. A frequent presenter at such events in the U.S., Dan has
spoken to planner groups on five continents and in recent years has led
delegations of U.S. planners to Russia and China on behalf of the FPA.

Editor’s note: Dan Moisand answers reader questions on all things retirement every Friday. If you have a question for Dan, please email him at RetireQA@marketwatch.com

Retirement involves a wide range of considerations and this week's column reflects that diversity. I give some brief answers to reader questions regarding Roth conversions, paying off debt, the changing nature of expenses during retirement, dividend stocks in annuity contracts and the “Single K”.

Q.I'm 73 years old, presently employed, contributing to a 401K, and in the 25% marginal tax rate. If I retire, between our pension and Social Security, we'll be near the $72,500 top end of the 15% bracket. Since I'm responsible for my annual RMD of $14,000 to the IRS, what are the pro and cons for me to convert from my IRAs to a Roth IRA?. -AL

A. First, make sure you are not taking a required minimum distribution (RMD) from the 401(k) where you are employed. Unless you own more than 5% of the company, no RMD is required from that 401(k). RMD's are required from other retirement plans and traditional IRAs but not Roth IRAs.

You can only convert amounts above the RMD, not the RMD itself. This means incurring additional ordinary income above and beyond the $14,000 you describe. Converting a traditional IRA to a Roth IRA makes the most sense if the tax rate that applies upon the conversion is lower than the tax rate that would apply when the money is eventually withdrawn. Based on what you have shared, you will pay at 25% either way but you could pay more if the extra taxable income from the conversion gets you into the 28% bracket (over $146,401 in 2013), making converting less than compelling.

However, if we consider life farther in the future, you may be more inclined to convert. After either of you pass away, the survivor will file as a single taxpayer beginning the year after death, causing a crossing into the 28% bracket at just $87,851 (2013 table). If you or your spouse would still receive enough pension, Social Security, and income from RMDs, you could easily find yourself paying at more than 25%. Converting can lower future RMDs because you will not have to take any RMDs from your Roth IRAs.

Also, if your kids have good salaries, paying tax now at 25% so they would not have to pay at a higher rate can be excellent cros- generational tax planning. Conversely, if your heirs will be in a low bracket or you have charities for your beneficiaries, converting is probably not wise.

Q. I'm 37, single, with a student loan at 2.625% and a mortgage at 2.875%. My employer only offers a 457b annuity plan. I'd like to retire by 60. Should I participate in this 457b plan with the high fee (there is no company matching) or should I open a Roth or traditional IRA? Should I accelerate the student loan payment since at my income I cannot deduct any of the interest or use the extra money to invest?

A. If your modified adjusted gross income (MAGI) exceeds $69,000, you cannot deduct any part of a contribution to a traditional IRA, so you should consider a Roth. However, if your MAGI exceeds $127,000, you can't contribute anything to a Roth either. If your income is that high, you are probably in the 28% tax bracket. With the 457(b) plan, you can lower your gross income by the amount of your contributions up to $17,500 in 2013. If you are in the 28% bracket, that's $4,900 in tax savings annually, probably more than enough to compensate for the high fees. You might also suggest to your employer that they seek a less costly provider.

As for the loan payoff, one bet you can make is whether you believe you can earn more on your investments than you pay in interest adjusting for taxes. Your after-tax cost of borrowing is 2.625% on the student loan. For the mortgage it is 2.875% less the value of any mortgage interest deduction you take on Schedule A of your 1040. Paying off either debt has the same effect as earning these rates, guaranteed.

In the world of guaranteed investments 2.625% is a pretty good outcome but for a well diversified investment portfolio, 2.625% is low by historical standards. You will find many people that would be confident they would do better than that, particularly over long periods.

Q.Are there any expenses for retirees that you know of that will be increasing in the near future that they should pay particular attention to and prepare for? -WB

A. The safest assumption is that most of your expenses during retirement will increase over time. In the near term, if your income is high enough, you should expect to pay more in taxes beginning this year. Also, young retirees often spend more on travel, and with fuel prices rising it may cost more to get places. As people age, they tend to spend a larger portion of their income on their health. Even if you have good health and long-term-care insurance, the premiums are likely to increase at a quicker pace than general inflation. Many new retirees underestimate the costs they incur to care for aging parents, and there is a growing trend that has more seniors caring for their grandchildren than in prior decades.

Q. I have $150,000 on a home equity line of credit (HELOC) and $190,000 in a retirement account. My pension check and my wife's wages cover our bills and allow us to pay toward the HELOC. We are considering using the retirement account to pay off the HELOC in one shot. Thoughts?-TR

A. For a lot of families, avoiding interest is very attractive, but Uncle Sam is watching. If the retirement account is the only source of funds, paying off the entire balance now is probably not going to be the best approach. In order to pay it off, you have to net $150,000 after-taxes on the withdrawal from the retirement account. If you add $190,000 of taxable income to your pension and wife's wages, you may find yourself in too high a tax bracket. Anything over a 21.05% rate would make paying it off all at once impossible. A better approach may be to pay it off over a few tax years to lower the effective tax rate. One downside to taking your time would be the potential for a variable rate on a HELOC to increase.

Q.What are the best dividend stocks inside an annuity for retirement?—GB

A. These days, most variable annuity contracts will have at least one separate account (basically a mutual fund) that will focus on dividend-paying stocks. If you already own an annuity, you can only choose among the separate accounts offered by that contract.

I would not suggest you buy an annuity simply because you like a particular separate account, nor would I automatically switch out of an annuity if I didn't like the lineup of separate accounts offered. Annuity contracts can be complex, and while the separate accounts are important, many other contract provisions affect a decision to buy or retain an annuity. Take your time, get a copy of the contract, and review it thoroughly before you buy one.

Q. We are 54 and 56. We have been putting $6000 each in Roth IRAs, for the last 4 years. We have a new home with a $350,000 3.75% 30-year mortgage, and we will clear $340,000 from our old home. Should we pay off the mortgage, and can we put some of this money in a Roth 401k or something similar since he works and I am self-employed as an artist?—M

A. “Should I pay off the mortgage?” is a common question. So much so, I hit a few of the highlights for another reader last month in the second question from To 401(k) or not to 401(k)?

Whether you can contribute to a Roth 401(k) is up to your husband's employer. The 401(k) plan has to allow for Roth contributions which provide no tax deduction now but allow for tax-free withdrawals later. Traditional 401(k) contributions are tax-deductible now, but subsequent withdrawals are taxable. If the plan has Roth provisions, your husband can save some or all of his contributions as Roth money. However, he can only make contributions through his payroll and cannot simply write a check from the proceeds of the sale of the house. In 2013, persons over 50 may contribute 100% of their income up to $23,000.

As a self-employed person, if you have no employees, you should look at “Single K”. You can give yourself Roth capabilities and make all or some of your contributions to the Roth up to $23,000.

Dan Moisand's comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you.

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